Attracting Private Equity Becomes a National Sport in Europe

By CARTER DOUGHERTY and JULIA WERDIGIER

Published: June 29, 2007

For most of the last decade, the private equity firms in Germany have argued for preferential tax treatment on the basis of national interest.

The breaks are needed, private equity managers said, to help Germany catch up with London and New York, the global centers of the buyout business.

These days, the United States and Britain are considering higher taxes on private equity, something that has not gone unnoticed in Berlin. And Rolf Christoph Dienst, head of BVK, the chief lobbying association for German private equity firms, would just as soon distance himself from either country.

''What is happening in the United States and Britain is not helpful,'' Mr. Dienst said, because it is undercutting the industry's message in Germany, particularly toward often hostile politicians on the left. ''The timing is very bad.''

As politicians in Washington begin to schedule hearings on whether to raise the tax rate on private equity, the major private equity markets in Europe -- Britain, France and Germany -- have faced the same issue with fiery debate and quiet lobbying.

In France, private equity has largely escaped the scrutiny it faces elsewhere; the country passed legislation in the last decade that offers stable tax treatment to private equity, and the conservative pro-business government of President Nicolas Sarkozy, who took office last month, is unlikely to change that.

In addition, Eddie Misrahi, director of Apax Partners in France and chairman of that country's industry association, AFIC, said that private equity was continuing a lobbying campaign aimed at cultivating its image among union and government officials.

''We have been perhaps slightly more conscious of a possible backlash from these kinds of deals,'' he said. ''Apparently our British and European colleagues have only recently discovered this approach.''

In Britain, Tony Blair, who was succeeded by Gordon Brown as prime minister on Wednesday, has said that it was time to rethink private equity taxation, and he promised a review by fall, when a committee of the British Treasury will issue a report.

Private equity firms, including Kohlberg Kravis Roberts & Company, have gone before a House of Commons committee to defend the lower tax rates and have argued that changes could drive parts of the industry out of Britain and into tax havens like Luxembourg.

At last week's hearing, Philip Yea, chief executive of the 3I Group, a London-based buyout firm, told members of Parliament that a tax increase ''might just mean that people like us might just invest our funds outside the U.K.''

Damon Buffini, the managing partner at Permira, and Dominic Murphy, a partner at Kohlberg Kravis Roberts, told the hearing that tax relief for some private equity investments had benefited Britain's economy by encouraging growth of the private equity industry. Committee members were unimpressed and said there was a sense that the industry's executives were ''arrogant'' and ''too rich'' while ''not paying enough tax.''

Yet even as the debate goes on, European politicians are torn. In Germany, when Franz M?fering, now the labor minister, was chairman of the country's Social Democratic Party, he referred to private equity firms as ''locusts'' who hollow out once-productive companies for their own benefit.

Yet politicians there have tended to favor venture capitalists who focus on young, growing companies, because they carry the potential for creating jobs. Britain's tax structure, which was developed about 10 years ago, was intended to help small companies and foster a start-up and venture capital culture. Known as the ''taper tax,'' it allowed investors to pay as little as 10 percent on investments, not the normal 40 percent rate on income.

German officials this week agreed on a draft law for venture capital that foresees tax incentives for financing of companies worth up to 20 million euros ($27 million) and a new form of incorporation for venture capital funds. But buyout funds, essentially the same concept at much higher valuations, enjoy no such sympathy.

''There is no sense in making special, preferential tax rules for big funds of capital,'' said Joachim Poss, a Social Democratic member of the German Parliament, and a leading voice on financial policy. ''But in our economy we do need new companies, especially in parts of Germany that are underdeveloped.''

The German private equity industry is determined to lobby hard for a new, more favorable tax.

At least for the last five years, Germany and other countries on the Continent have watched Britain grab the bulk of European private equity and turn it into a driving force for economic growth. Funds in Britain last year raised 75 billion euros ($100.8 billion), or 67 percent of the total raised in Europe, according to the European Venture Capital Association; 3 percent was raised in Germany.

Right now the dominant players in Germany tend to be British and American funds. Terra Firma, an investment firm based in London, and Fortress Investment, based in New York, for example, have done large deals in Germany, but have mitigated this risk by using companies based elsewhere.

The German industry argues that until German funds can flourish, they cannot win the confidence of the companies they might acquire, many of them family-owned and suspicious of outside financing.

When it took office in 2005, the coalition that runs Germany -- an unwieldy mix of conservative Christian Democrats and Social Democrats -- promised a comprehensive private equity law. The business-friendly Social Democratic finance minister, Peer Steinbr? is thought to be sympathetic, but he has already had to wrestle with his party's left wing to push through a broader corporate tax overhaul and new legislation on real estate investment rules.

Doing a favor for private equity, Mr. Dienst of the German association said, might be beyond Mr. Steinbr?s grasp.